Rough indicators of dollar dominance

Ingvild Borgen is a rates and FX analyst and Kelly Chen is an economist at DNB Markets.

Ray Dalio has a rare gift for understanding both the details and the big ramifications of economic developments. But he has a blind spot when it comes to the Chinese renminbi.

The Bridgewater founder argued earlier this year that the Chinese renminbi was becoming more international and was threatening the US dollar’s global hegemony. While the former may be true, the latter is a stretch. A large.

Arguably the best example of the unique status of the US dollar is in the global oil trading market. Most of the trade is denominated in US dollars, although neither the barrels of crude nor the parties trading it have anything to do with the US.

It is understandable, therefore, that China’s start paying for oil in renminbi is often seen as a major step towards a more “multipolar” international monetary system in which the US dollar is losing ground against the Chinese renminbi. CNN’s Fareed Zakaria is the latest pontificator to highlight this.

However, the increased importance of the Chinese renminbi in global oil trading is massively overestimated.

When trading oil, as with most commodities, hedging is key. In 2022, the daily average of traded volumes and open interest in the primary global crude futures markets was over 7 billion barrels. That’s about 88 times the world’s daily crude oil production. The “multiplier” of world crude oil production on the crude oil futures markets is thus 88.

China wants to buy more oil in renminbi and must actually buy non-US dollar oil as some key suppliers (Iran, Venezuela and Russia) are subject to US sanctions. China established its own commodity exchange – the Shanghai International Energy Exchange (INE) – in Shanghai in 2018 for oil futures contracts settled in renminbi with physical delivery.

The contracts traded there are denominated exclusively in the Chinese renminbi, while all other contracts traded worldwide are denominated in US dollars. However, the amounts traded in Shanghai remain fairly small.

Total open interest and traded volume (mb/d) © Bloomberg, DNB

During the last three months of 2022, the daily average trading volumes and open interest rate contracts of crude oil futures on INE were equivalent to 333 million barrels.

For comparison, Brent and WTI crude oil contracts traded on ICE and NYMEX averaged nearly 6 billion barrels over the same period. Shanghai accounted for 5.1 percent of total trade.

Moreover, since serious activity on the exchange began in late 2018, this percentage has increased only slightly.

Total open interest in volume traded, % Shanghai © Refinitiv, DNB Markets

In December, China required more of its suppliers — not just those sanctioned by the US — to do business in Shanghai and accept payments in renminbi. A possible deal between China and Saudi Arabia also attracted some attention late last year. That’s understandable given that a deal between the world’s largest oil exporter and the largest single importer could potentially involve large volumes denominated in renminbi rather than US dollars. But does it really move the needle?

Nothing was formally agreed, but even if we assume that about 1/3 of the roughly 1.5 million barrels per day of Saudi Arabia’s exports to China are settled in Renminbi, this would mean that an additional 0.5 million Barrels per day are traded directly on the Shanghai exchange. The direct impact is minimal considering the exchange’s average daily trading volume in the fourth quarter of 2022 was 245 million barrels.

Exports from Saudi Arabia are often sold under fixed-term contracts, with regular flows of agreed quantities and, importantly, at a price broadly below the US dollar-denominated Brent benchmark. Ultimately, therefore, price risk remains largely associated with Brent, and physical volumes settled in Renminbi are unlikely to trigger a major shift in participation in financial futures markets.

For the sake of simplicity, assuming that the increase in renminbi-denominated futures contracts traded increased in line with the global multiple of 88, that would mean an increase of 44 million barrels. Other things being equal, the volumes traded in Shanghai would then account for 5.8 percent of global trading volume, instead of the current 5.1 percent.

The Crazytown scenario

Let’s be unrealistic for a second and assume that Saudi Arabia is willing to accept Renminbi payments for all the oil it sells to China. Even if that were the case — and volumes traded in the renminbi futures market had increased 88-fold — Shanghai would still account for just 7.1 percent of the world total.

Let’s go one step further and assume that all Chinese oil imports are settled in Renminbi. This would (based on the same assumptions) cause the renminbi-based oil futures contracts share to rise to 15-20 percent of the global total. The remainder would continue to be denominated in US dollars.

These back cover calculations show that even in an extreme scenario where China buys all of its oil in renminbi, the US dollar would still dominate oil trading.

These calculations assume a multiplier of 88 from physical renminbi oil settlements and the resulting increase in futures trading on the INE in Shanghai. For the international benchmark Brent, this multiple is in the order of 1000, meaning that the volume traded on the futures market is more than 1000 times the physical trading underlying the Brent benchmark.

Just how big the potential multiplier for renminbi settlements in Shanghai might be brings us back to the core question. It depends on whether a new international crude oil benchmark contract – based on renminbi and traded in Shanghai – could emerge and challenge the current international Brent benchmark in US dollars.

If that were the case, the multiplier could be much higher, and trading in renminbi-based futures contracts could account for a far larger proportion of the total. But unless there is a renminbi-denominated benchmark, this will not be the case.

China cannot “internationalize” its currency simply by paying for all its oil imports in renminbi. It has to convince third parties to also trade in renminbi. Even if more Russian barrels were priced in renminbi, that wouldn’t make the INE a global crude oil benchmark either.

This is a far more difficult achievement, contingent on much more complex issues, than China’s share of total world oil imports. People may occasionally be unhappy with the dollar’s dominance and the power it bestows on Washington, but would they really feel safer with the renminbi?